It’s not as simple as ‘when rates rise buy loans; when rates fall buy bonds.’ Indeed, a combination of several factors has set the stage for loans to potentially deliver attractive total returns going forward.
Since the onset of the pandemic, a combination of technical factors has slowed the recovery of the loan asset class, while at the same time providing a tailwind to other fixed income asset classes, such as high yield bonds. As a result, we believe loans now offer compelling relative and absolute value, and—as the technical backdrop begins to improve—present a potentially attractive total return opportunity going forward. In particular, there are three reasons we believe loans represent attractive relative value, even in what looks likely to be a lower-for-longer rate environment.
1. Loan and Bond Yields Are Comparable
As central banks provided unprecedented stimulus following the initial onset of COVID-19, high yield bonds in particular experienced a strong resurgence. Retail funds saw significant inflows—the U.S. market, for instance, has experienced more than $60 billion1 of inflows since April—and spreads have tightened substantially. The rebound for loans, which did not benefit as much from the stimulus measures, has been slower to materialize—and fund flows have remained largely negative in a continuation of the last two years, when expectations for lower rates drove many investors out of loans, which are floating rate, and into fixed rate assets. As a result, the global loan market, on average, continues to trade at a discount to par, with an average price of roughly 952—versus the global high yield bond market, which is trading above par with an average price of 102.3 These technical factors, and the sentiment-driven shift from loans to bonds, have caused the yield differential between the two asset classes to remain compelling for loans despite the decline in short-term rates in the U.S.
1. Source: J.P. Morgan. As of November 30, 2020.
2. Source: Credit Suisse. As of November 30, 2020.
3. Source: Bank of America Merrill Lynch. As of November 30, 2020.